SEC Corporate Governance
SEC Corporate Governance in the 21st Century
Corporate governance refers to a regulatory system that balances company, stakeholder, and government interests. [i] It assumes an agency relationship whereby one or multiple persons, including companies—agents—provide services on another’s behalf—principals. [ii] Here, principal beneficiaries entrust agents with a requisite fiduciary responsibility—relationship based on duty, loyalty, and trust in confidence—to act on their behalf.
The United States Securities and Exchange Commission (SEC)—federal administrative agency regulating securities commerce—oversees corporate governance, balancing agency fiduciary interests among investors.
Established in 1934, the SEC regulates investment exchanges, monitors required broker disclosures and provides investors accessible information on publicly traded companies. Additionally, with its emphasis on transparency, the SEC stipulates general financial disclosure guidelines for securities transactions. Among its responsibilities include, inter alia:
Investigating CEOs suspected of illegal activity, e.g., crime, fraud/negligent misrepresentation, embezzlement/earnings manipulation, theft, conflicts of interest fiduciary violations—acting adversely to others’ interests, etc.
Enforcing securities laws, ensuring ethical, legal, prudent investment decisions among financial institutions, policing violations, and sanctioning violators.
The 21st Century spawned a new generation of modernization—manifest in computer digitization. In 2000, international investment exploded. Technology became the impetus. By year-end, nearly 1400 foreign companies spanning 55 countries reported with the SEC, accompanied by public offerings exceeding $211 Billion. [iv] Consequently, this paradigmatic technological transition appeared to reflect the “transformational changes” in corporate governance over time. [v]
The synchronizing market interdependence in exchange of foreign resources from globalization correlated with heightened regulation as inferred to accommodate increased potential for cybersecurity crimes. SEC expansion of internet policing systems supports this conclusion. For example, on April 24, 2000, the SEC expanded Electronic, Data, Gathering, Analysis, and Retrieval (EDGAR) Modernization, to transmit online filings and target web-based fraud. [vi] Additionally, the Commodity Futures Modernization Act of 2000 (CFMA)—allegedly seeking “reduced systemic risk for futures/over-the-counter derivatives”—presumably precipitated SEC negotiations. [vii] SEC regulatory reform plausibly represents an outgrowth of the 1999 Gramm-Leach-Bliley Act designed to regulate individual privacy. [viii]
Litigation signified similar trends. SEC v. Sargent, insider trading case, held that circumstantial evidence suffices for a fiduciary violation if an alleged tipper entrusted to preserve confidentiality discloses material information. [ix] Here, circumstantial evidence means the jury need not actual evidence but indirect knowledge/reason to infer such a violation by virtue of one’s implied agency authority. By acknowledging implied authority of non-disclosure, the court imputed a fiduciary duty to preserve confidentiality.
A fiduciary duty assumes trust in the element of loyalty. In other words, the court entrusted alleged tippers with a duty of non-disclosure where divulging personal pecuniary details risks harming/materially affecting another’s financial position. Ultimately, Sargent illustrates attempts to restore public confidence in a judicial decision that reinforces regulatory reform, bolstering trust by recognizing fiduciary standards for information disclosure requirements. If true, these developments in 2000—suggesting increased SEC regulation—plausibly set the stage for subsequent SEC regulatory reform to improve transparency as globalization advanced.
The devastating September 11, 2001, terrorist attacks on American soil irrevocably altered financial market regulations. Discussion presumably ensued between the SEC, Federal Reserve, New York Banking Department and numerous financial institutions to strengthen emergency planning systems in circumventing operational disruptions. [x] 9/11 revolutionized regulatory reform. The volatile, vulnerable, insidious terrorist threats in a post-9/11 world posed precarious technological implications. Accordingly, the SEC presumably incorporated Patriot Act provisions, “deter international money laundering and combat terrorist financing.” [xi]
The fiscal year 2002 culminated with the historic, high-profile Enron and WorldCom scandals, ushering in a wave of landmark legislation to tighten SEC regulatory reform. [xii] For instance, 43rd President George W. Bush authorized Congress to introduce the Sarbanes-Oxley Act of 2002, facilitating transparency through corporate responsibility. Sarbox provided, inter alia, the following internal control measures:
- Improve financial disclosures;
- Combat corporate/accounting fraud;
- Instituted Public Company Accounting Oversight Board (PCAOB) for auditing activities—requiring supervision from “only independent, outside directors”; [xiii]
After its enactment, the 2002 SEC Enforcement Division reported a “record 598 actions—24% increase since 2001.” [xiv] Therefore, if accurate, the reportedly unprecedented regulatory reform to corporate governance plausibly correlates with Sarbanes-Oxley.
Past SEC Criticisms
The SEC ostensibly satisfied qualified assurance for its system of controls in 2004. [xv] Notwithstanding aforementioned achievements, criticisms remain. Some past SEC criticisms include:
- FY 2002—SEC purportedly collects “$2 Billion” in fees—5 times its budget; [xvi]
- FY 2002—Allegedly insufficient staff size to police a market encompassing approximately $12 trillion; [xvii]
- FY 2004—material nonconformance in auditing financial statements, delaying fraud detection under Federal Managers’ Financial Integrity Act (FMFIA); [xviii]
- FY 2003-2008—hedge fund registration deemed “a mistake” because it allegedly, “diverts SEC resources from protecting mom-and-pop investors”; [xix]
However, some of these past criticisms proved unwarranted due to contradictory evidence. For example, Congress implies certain 2002 legislation prevented “the SEC from collecting 5 times its annual budget in fees.” [xx] If true, this assertion presents a fact-checking issue, negating the earlier contention for questionable inaccuracy. Nevertheless, a “smaller budget despite pleas of underfunding from the SEC,” suggests noteworthy consideration according to former SEC attorney Hester Peirce. [xxi]
Moreover, the issue of staff size seems implausible. First, it assumes without warrant that staff size determines budget efficiency, neglecting other relevant factors plausibly assumed by competently managing a $12 trillion market. For instance, commissioners serve appointed terms by the President in facilitating impartiality, preventing undermined efficiency from ideological influence. Five commissioners serve 5-year tenures with no more than three permitted from the same party to limit partisan prejudice. [xxii]
Secondly, what constitutes understaffing? The SEC retains nearly “4,000 staff members” among four divisions. [xxiii] The SEC apparently acted on “1,133 staff recommendations” in 2000. [xxiv] By 2013, SEC Chair Mary Jo White acknowledged the SEC’s “4,000” members as “well-positioned” to manage “more than $12 trillion in assets.” [xxv] If true, understaffing appears questionable. Even so, some “understaffing” remains virtually ineluctable if defined by one disproportionately small agency network compared to an increasingly globalized market supporting billions of people. Therefore, while “understaffing,” may arguably exist as reasonably inferred from a $12 trillion market, if anything, excess regulation contributes to this issue. Why? Expanding market regulation assumes greater supervision, which typically entails additional divisions with more personnel. Dodd-Frank, discussed next, demonstrates this issue. [xxvi]
FY 2010 & Forward
The Dodd-Frank Wall Street Reform & Consumer Protection Acts
Fast forwarding to 2010 through 2016, 44th President Barrack Obama via Congress devised Dodd-Frank—expansionary regulatory outgrowth of the 2007-2008 Great Recession. Banks unreasonably assumed inordinate default-risk from debt on insufficiently collateralized, low-credit, sub-prime mortgage borrowers, consequently culminating in insolvency, unable to collect payments, defaulting loan-debt obligations. Hence, excess default-risk on debts tied to foreign investments triggered widespread bank collapse, correlating with what subsequently became known as the Great Financial “Credit” Crisis. Dodd-Frank presumably originated as a remedial measure to resurrect regulatory pressure after years of perceived de-regulation in possibly preventing another similar calamity. Instituted on July 10, 2010, Dodd-Frank imposed the following SEC corporate governance regulations:
- Trade restrictions; [xxvii]
- Credit history investigation on mortgage applicants to reduce default risks;
- Financial product and portfolio risk management regulations in private sector;
- SEC Credit Ratings Office to regulate rating agencies with internal controls;
- Reporting requirements on private fund investments to assess systemic risks. [xxviii]
Latest SEC Criticisms—2013-2016
Recent SEC Criticisms over the past few years allegedly include:
- Fixed money fund prices abandoned to replace with floating-share price requirements; [xxix]
- Complaints that SEC failed to target those responsible for financial collapse; [xxx]
- Increased SEC regulation via Dodd-Frank projects a false sense of security; [xxxi]
- Dodd-Frank protectionism divests market participants chance to learn from mistakes; [xxxii]
- Failing to aggressively enforce securities laws and protect investments; [xxxiii]
- Avoiding litigation with banks to opt for settlements; [xxxiv]
- Omitting individuals’ names from enforcement actions; [xxxv]
Indeed, Dodd-Frank risks discouraging market participation with restrictive SEC auditing to ensure transparency without necessarily incentivizing discipline from “consequences” by eliminating autonomous decisions. [xxxvi] Why? Dodd-Frank’s requirements regulate market behavior in “seeking to reduce systemic risk”—standardized investment ratings and limits imposed on firms’ portfolios. [xxxvii] Likewise, replacing fixed money fund prices with floating-share price requirements, likely exacerbates—rather than reduces—volatility and systemic risk due to unpredictable price fluctuations. [xxxviii] Nevertheless, notwithstanding this needless regulation expansion from Dodd-Frank, many foregoing SEC criticisms neglect, inter alia, the following:
- In FY 2015, the SEC filed 807 enforcement actions—presumably a historical record;[xxxix]
- FY 2015—SEC reports $3.76 billion in penalties & disgorgement from financial crisis;[xl]
- From 2012-2015, the SEC allegedly averaged $38.7 billion in annual penalties; [xli]
- 2013 study revealed individuals named in 93 percent” of SEC cases; 96% for fraud;[xlii]
- 2013 study found CEOs, CFOs, & other execs named in at least 56% of SEC cases; [xliii]
- Reportedly 70 cases against CEOs, CFOs, & senior execs from the financial crisis. [xliv]
- Confidentiality often precludes reports on “thousands” of smaller cases; [xlv]
- Settlements ensure penalties; litigation risks 50-50 odds of violator escaping unpunished;
- Blackstone Group LP agreed in 2015 to a $39 million SEC settlement. [xlvi]
If true, all evidence overwhelmingly contradicts the foregoing SEC criticisms. Therefore, contentions of unaggressive SEC sanctions constitutes conjecture. The same applies for unsubstantiated complaints about failing to target culpable parties in financial crisis because they lack evidentiary support.
[i] See Carver, John, Carver, Miram, Basic Principles of Policy Governance, The Carver Guide Series on Effective Board Governance, No. 1, San Francisco: Jossey-Bass, 1996, p. 1; See Investopedia, LLC, Corporate Governance, 2016, p. 1, http://www.investopedia.com/terms/c/corporategovernance.asp.
[ii] See Besley & Brigham, Essentials of Managerial Finance, 14th Edition, Thomson South-Western, 2008, 2005, p 17.
[iii] See Carver, John, Basic Principles of Policy Governance, A Theory of Corporate Governance, Finding a New Balance for Boards & their CEOs, 2006, p. 1, http://www.carvergovernance.com/pg-corp.htm; See Carver, John, Boards that Make a Difference: A New Design for Leadership in Non-Profit and Public Organizations, Third Edition, 2006.
[iv] See U.S. Securities and Exchange Commission, Annual Report (2000)—Full Disclosure System, 2000, p. 72, https://www.sec.gov/pdf/annrep00/fulldisc.pdf.
[v] See Carver, John, Carver, Miriam, Reinventing Your Board: Step-By-Step Guide to Implementing Policy Governance, John Wiley & Sons, 1997, p. xiv, Preface.
[vi] See U.S. Securities and Exchange Commission, Annual Report (2000)—Full Disclosure System, 2000, p. 73, https://www.sec.gov/pdf/annrep00/fulldisc.pdf; See Mazmanian, Adam, SEC Plans a Makeover for EDGAR, The Business of Federal Technology, 1105 Media, Inc., Jul. 21, 2014, p. 1, https://fcw.com/articles/2014/07/21/sec-plans-for-edgar.aspx.
[vii] See Civic Impulse, LLC, H.R. 4541 (106th): Commodity Futures Modernization Act of 2000, GovTrack, 2004, p. 1, https://www.govtrack.us/congress/bills/106/hr4541; See U.S. Securities and Exchange Commission, Annual Report (2000)—Other Litigation and Legal Activity, 2000, p. 91, https://www.sec.gov/pdf/annrep00/otherlit.pdf.
[viii] See U.S. Securities and Exchange Commission, Annual Report (2000)—Regulation of Securities Markets, 2000, p. 29, https://www.sec.gov/pdf/annrep01/ar01marketr.pdf.
[ix] SEC v. Sargent, 229 F.3d 68 (1st Cir. 2000).
[x] See U.S. Securities and Exchange Commission, Summary of “Lessons Learned” from September 11 and Implications for Business Continuity, Feb. 13, 2002, p. 3-5, https://www.sec.gov/divisions/marketreg/lessonslearned.htm.
[xi] See U.S. Securities and Exchange Commission, SEC Accomplishments Fiscal Year 2002, Oct. 22, 2002, p. 2, https://www.sec.gov/news/extra/initsfy2002.htm.
[xii] See Spiceland, David J., Thomas, Wayne, Herrmann, Don, Financial Accounting, 4th Edition, McGraw-Hill Education, 2016, p. 169.
[xiii] See U.S. Securities and Exchange Commission, What We Do, Jun. 10, 2013, p. 13, https://www.sec.gov/about/whatwedo.shtml; See Westerfield, Ross, Jordan, Jaffe, Corporate Finance 11th Edition, McGraw-Hill Education, 2016, p. 17.
[xiv] See U.S. Securities and Exchange Commission, SEC Accomplishments Fiscal Year 2002, Oct. 22, 2002, p. 2, https://www.sec.gov/news/extra/initsfy2002.htm.
[xv] See U.S. Securities and Exchange Commission, Performance and Accountability Report—2004, 2004, p.34, https://www.sec.gov/about/secpar/secpar04.pdf.
[xvi] Manley, John, Ph.D., Governance, PowerPoint, Slide 14, 2016, adapted from Fortune (July 1, 2002), Restore Confidence with Reforms.
[xvii] Manley, John, Ph.D. Governance, PowerPoint Slide 14.
[xviii] See U.S. Securities and Exchange Commission, Performance and Accountability Report—2004, 2004, p.34, https://www.sec.gov/about/secpar/secpar04.pdf.
[xix] Ackerman, Andrew, SEC Nominee Hester Peirce Is Outspoken Critic of Postcrisis Regulation, Wall Street Journal, Mar. 14, 2016, 2:08 p.m. ET, p. 3, http://www.wsj.com/articles/sec-nominee-hester-peirce-is-outspoken-critic-of-post-crisis-regulation-1457978884.
[xx] U.S. Congress, United States Congressional Serial Set, Serial No. 14753, House Document, Budget of United States Government, Fiscal Year 2003, p. 392.
[xxi] See Ackerman, Andrew, SEC Nominee Hester Peirce Is Outspoken Critic of Postcrisis Regulation, Wall Street Journal, Mar. 14, 2016, 2:08 p.m. ET, p. 3, http://www.wsj.com/articles/sec-nominee-hester-peirce-is-outspoken-critic-of-post-crisis-regulation-1457978884.
[xxii] See U.S. Securities and Exchange Commission, Current SEC Commissioners, p. 1, Sept. 17, 2013, p. 1, http://www.sec.gov/about/commissioner.shtml.
[xxiii] Financial Dictionary, Securities and Exchange Commission, 2015, p. 1, http://www.financialdictionary.net/define/Securities+and+Exchange+Commission+(SEC)/.
[xxiv]See U.S. Securities and Exchange Commission, Annual Report (2000)—Policy Management and Administrative Support, 2000, p. 115, https://www.sec.gov/pdf/annrep00/polmgmt.pdf. ,
[xxv] See U.S. Securities and Exchange Commission, Knowing Your SEC: A Tribute to the SEC Staff, Nov. 6, 2013, p. 5-6, https://www.sec.gov/News/Speech/Detail/Speech/1370540284590.
[xxvi] See Think Advisor, SEC is Woefully Understaffed to Fulfill Dodd-Frank, Review Reportedly Finds, Mar. 7, 2011, p. 1, http://www.thinkadvisor.com/2011/03/07/sec-is-woefully-understaffed-to-fulfill-doddfrank.
[xxvii] See U.S. Securities and Exchange Commission, What We Do, Jun. 10, 2013, p. 13, https://www.sec.gov/about/whatwedo.shtml; See Westerfield, Ross, Jordan, Jaffe, Corporate Finance 11th Edition, McGraw-Hill Education, 2016, p. 17.
[xxviii] See U.S. Securities and Exchange Commission, Annual Staff Report Relating the Use of Data Collected from Private Fund Systemic Risk Reports, Aug. 13, 2015, p.2, https://www.sec.gov/investment/reportspubs/special-studies/im-private-fund-annual-report-081315.pdf.
[xxix] See Ackerman, Andrew, SEC Nominee Hester Peirce Is Outspoken Critic of Postcrisis Regulation, Wall Street Journal, Mar. 14, 2016, 2:08 p.m. ET, p. 3, http://www.wsj.com/articles/sec-nominee-hester-peirce-is-outspoken-critic-of-post-crisis-regulation-1457978884.
[xxx] See ElBoghdady, Dina, Here’s How the SEC is preparing for Life after Financial Crisis, The Washington Post, Jan. 29, 2014, p. 1, https://www.washingtonpost.com/news/wonk/wp/2014/01/29/sec-enforcement-chief-gears-up-for-post-financial-crisis-era/.
[xxxi] See Peirce, Hester, Broughel, James, Dodd-Frank, What it Does and Why It’s Flawed, Mercatus Center, Library of Congress, 2012, p. 13.
[xxxii] See Tricchinelli, Rob, A Fierce Regulatory Critic is Set to Join SEC, Bloomberg.com, The Bureau of National Affairs, Mar. 14, 2016, p. 2, http://www.bna.com/fierce-regulatory-critic-n57982068507/.
[xxxiii] See U.S. Securities and Exchange Commission, Letter from Senator Elizabeth Warren to the Honorable Mary Jo White, Jun. 2, 2015, http://www.warren.senate.gov/files/documents/2015-6-2_Warren_letter_to_SEC.pdf.
[xxxiv] Senator Elizabeth Warren Embarrasses Bank Regulators at First Hearing!, Feb. 16, 2013, https://www.youtube.com/watch?v=O_riLcZicZA.
[xxxv] McCoy, Kevin, Warren Seeks Public Hearing on Bank Waivers, USA Today, May 25, 2015, 11:26 EDT, p.1, http://www.usatoday.com/story/money/2015/05/25/elizabeth-warren-criticizes-bank-waivers/27911773/.
[xxxvi] See Tricchinelli, Rob, A Fierce Regulatory Critic is Set to Join SEC, Bloomberg.com, The Bureau of National Affairs, Mar. 14, 2016, p. 2, http://www.bna.com/fierce-regulatory-critic-n57982068507/.
[xxxvii] See Acharya, Viral, Richardson, Matthew, The Dodd-Frank Act, Systemic Risk and Capital Requirements, Oct. 25, 2011, p.1, http://voxeu.org/article/dodd-frank-act-systemic-risk-and-capital-requirements.
[xxxviii] See Davis, Philip, E., Debt, Financial Fragility, and Systemic Risk, 1992, 1995, p. 178; See Westerfield, Ross, Jordan, Jaffe, Corporate Finance 11th Edition, McGraw-Hill Education, 2016, p. 350; See Finnerty, John D., Project Financing, Asset-Based Financial Engineering, John Wiley & Sons, Inc., 3rd Edition, 2013, p. 273; See Investopedia, LLC, Volatility, 2016, p. 1, http://www.investopedia.com/terms/v/volatility.asp.
[xxxix] See U.S. Securities and Exchange Commission—
SEC Press Release, SEC Announces Enforcement Results for FY 2015, Oct. 20, 2015, p. 1, https://www.sec.gov/news/pressrelease/2015-245.html.
[xl] See U.S. Securities and Exchange Commission, SEC Enforcement Actions: Addressing Misconduct that Led to or Arose from the Financial Crisis, Jan. 13, 2016, p. 1, https://www.sec.gov/spotlight/enf-actions-fc.shtml.
[xli] See Committee on Capital Markets Regulation, Committee Releases Q1 2016 Financial Penalties Data, April 15, 2016, p. 1, http://capmktsreg.org/news/committee-releases-q1-2016-financial-penalties-data/.
[xlii] See Klausner, Michael, Hegland, Jason, SEC Practice in Targeting and Penalizing Individual Defendants, Harvard Law School Forum on Corporate Governance and Financial Regulation, Sept. 3, 2013, p. 1, https://corpgov.law.harvard.edu/2013/09/03/sec-practice-in-targeting-and-penalizing-individual-defendants/.
[xliii] See Eisenberg, Jon, Hastings, Shanda N., Recent Criticisms of the SEC: Fair or Unfair?, May 9, 2016, p. 2, http://www.klgates.com/recent-criticisms-of-the-sec-fair-or-unfair-05-09-2016/#_ednref14.
[xliv] See ElBoghdady, Dina, Here’s How the SEC is preparing for Life after Financial Crisis, The Washington Post, Jan. 29, 2014, p. 1, https://www.washingtonpost.com/news/wonk/wp/2014/01/29/sec-enforcement-chief-gears-up-for-post-financial-crisis-era/.
[xlv] See U.S. Securities and Exchange Commission, Knowing Your SEC: A Tribute to the SEC Staff, Nov. 6, 2013, p. 2, https://www.sec.gov/News/Speech/Detail/Speech/1370540284590.
[xlvi] See Michaels, Dave, Jarzemsky, Matt, SEC Probes Silver Lake Over Fees, Wall Street Journal, Aug. 19, 2016, p. 2, http://www.wsj.com/articles/sec-probes-silver-lake-over-fees-1471646427.